Italy, Spain yields fall on speculation ‘ECB’

LONDON: Italian and Spanish bond yields came back off 14-year highs on Thursday due to a well-bid Spanish debt auction and speculation that Japan's intervention to weaken the yen will inspire the ECB to revive its dormant bond-buying programme.

Signs that the euro zone debt crisis could soon swallow countries that are seen as "too big to fail" raised expectations that policymakers could soon act to temper the Italian and Spanish sell-off, and the European Central Bank's meeting later in the day is seen as the first opportunity to do that.

However, analysts say there is significant scope for disappointment for those who put their money on it.

"There's been speculation the ECB's waiting in the wings to calm the market, which we think it is highly unlikely," Citi interest rate strategist Steve Mansell.

"The ECB is going to be a very reluctant participant to any kind of market turbulence that's a direct result of sovereigns not stepping up and doing the required amount in terms of fiscal adjustment and negotiating more credible support packages."

Italy's 10-year yield was last 5.7 basis points down on the day at 6.047 percent, after briefly dipping below 6 percent earlier in the session. The Italian/German 10-year spread was 18 basis points tighter at 351 bps, while the Spanish/German spread was last 23 bps narrower at 363 bps.

A feeling that the current policy tools are not enough to temper contagion risks in the euro zone and broad concerns about a slowdown in the global economy, have sent those yields to 14-year highs. Belgian and French yield spreads over German Bunds also hit euro era highs this week.

The European Commission called on Thursday for a re-assessment of all elements of the euro zone's current and future bailout funds, including size, to convince markets the euro zone can respond to the debt crisis.

With many investors not willing to buy in to Spanish and Italian debt, official purchases may be the only immediate solution that would stop the rot, some analysts say.

"We are at alarming (yield) levels. There's the risk that you get this self-fulfilling spiral. To stop this you need a buyer and institutional (backing) will help," said Rainer Guntermann, strategist at Commerzbank.

Euro zone policymakers have agreed to allow the EFSF to intervene in secondary markets, but the changes need to be ratified by national parliaments and this could take months. Also, the size of the fund is seen insufficient to help Italy or Spain if they need it.

Any bond purchases are not a long-term solution, however.

"When you're looking at one the biggest bond markets in the world the idea that ECB buying is some form of panacea or cure for the current woes looks a little bit misplaced," said Marc Ostwald, strategist at Monument Securities.

Spanish bonds extended gains by a touch after figures showed decent demand at an auction of 2014 and 2015 bonds. The country did have to pay significantly higher yields, reflecting the recent sell-off.

Some players, however, cast doubt on how much longer market makers will be willing to buy from Spain and Italy at auction and sentiment may worsen further if the ECB fails to signal willingness to buy bonds.

Money markets have all but priced out any more rises in ECB interest rates this year and with two-year German bond yields at 1.05 percent, flat on the day, there is a widespread feeling that July's hike to 1.5 percent was a policy error.

"I don't think Trichet is going to change his tone monetary policy will still be accommodative and they will monitor (inflation) closely," one trader said.

"But at the end of the day we're not trading the market from a value perspective, we're trading the market from a safety perspective."

Bund futures were last 23 ticks higher at 132.07 after hitting session lows of 131.31 earlier, in a sign that safe-haven paper will remain well bid in the near future.

Copyright Reuters, 2011